Libya: Why a Two-Percent Oil Producer is Rattling Global Markets

Updated at 8:48 a.m. on February 24.

Libya produces only about 2 percent of the world’s oil, and Saudi Arabia alone has enough spare capacity to make up for any lost production if Libya plunges into prolonged chaos.

Ordinarily, those two factoids might be enough to allay economic anxiety about Muammar el-Qaddafi’s violent battle to remain Libya’s strongman.

Not this time. On Wednesday, for the third day this week, the turmoil in Libya spawned fear around the world and in almost every financial market. The price of Brent crude, a benchmark for global oil prices, passed $110 a barrel today and was up about 8 percent this week.  

Meanwhile, U.S. stocks slumped for the second day in a row today, largely on fears about Libya, and the volatility of stock prices has climbed to the highest level since December. The price of gold, another haven in times of fear, jumped $15 today to $1,413 an ounce. Silver prices hit a 31-year high on Tuesday and are still climbing. And far from the oil markets, corporate bond investors have become notably more risk averse.

Most analysts do not think that Libya can wreak anything like the havoc caused by the 1973 OPEC oil embargo. Before the protests broke out this month, it was producing about 1.6 million barrels per day. To put that in perspective, oil production dropped by about 1 million barrels a day in 2005 when Hurricanes Katrina and Rita forced companies in the Gulf of Mexico to shut down many of their wells. It was a disruption, but not an economic catastrophe.

But Libya is big enough to make a difference, and the turmoil is not taking place in a vacuum. It is happening against a backdrop of unrest throughout the region -- and rising demand for oil from developing countries. 

Even though Saudi officials pledged this week to ramp up their production to fill any shortfall, no one knows if Qaddafi will be the only Middle East oil autocrat in danger of being toppled.

“Libya is the first major oil exporter to be actually affected by the protests,” said Jim Burkhard, managing director of the global oil group at IHS CERA, an energy consulting firm based in Cambridge, Mass. “If you add into that this historic change in the Middle East, then you have greater anxiety about rising oil prices.”

The basic math works out as follows. Libya normally produces about 1.6 million barrels of oil per day. The world has spare oil production capacity of 4 to 5 million barrels per day, much of which is in Saudi Arabia.

The problem is that global demand for oil has climbed faster than expected since the financial crisis receded two years ago. Last year, Burkhard estimated, global oil demand shot up at its fastest pace in more than 30 years.

In itself, the loss of Libyan production wouldn’t be cataclysmic for oil-importing countries. But it would sharply reduce the amount of buffer that the world has in spare capacity, which would mean that even small additional shocks would have steadily bigger impacts on prices.

“If financial market participants were assured that unrest could be confined to Libya, oil prices would come down noticeably,” said John Lonski, chief economist at Moody’s Capital Markets. “A lot of this is driven by anxiety.”

Lonski said the uncertainty is now beginning to creep into credit markets, which reflects growing perception of risk in the broader economy. Though corporate bond yields have not climbed much, spreads have widened on credit-default swaps, which are like insurance policies against the default of particular bonds.

The benchmark price for U.S. oil -- West Texas Intermediate -- climbed past $98 a barrel today, up from $86 last Friday.

“My own impression would be -- if the WTI crude is now approaching $100 -- if that were to go ahead and reach $120 and stay there, you would soon thereafter see a price of gasoline approach $4 a gallon on a nationwide average,” Lonski said. “That would lead to significant downward revisions of GDP growth.

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